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Tuesday, May 05, 2015

Concerns about Atal Pension Yojana

In the recent budget, the Finance Minister announced
the Atal
Pension Yojana, which promises a fixed pension of at least
Rs.1,000 at age 60 if subscribers contribute pre-defined amounts
over their working life. The APY suffers from five problems.

1. Clarity of
objective. The NPS-Swavalamban
(NPS-S) has been the flagship pension scheme for the informal
sector since 2010. While it has taken root over the last few
years, problems in the design and process of the scheme
persist. The APY seems to be motivated by these concerns. The
scheme document says: `... coverage under Swavalamban Scheme is
inadequate mainly due to lack of clarity of pension benefits at
the age after 60. The Finance Minister has, therefore, announced a
new initiative called Atal Pension Yojana (APY) in his Budget
Speech for 2015-16'. Clarity of pension benefits could be
interpreted as clarity of process for receipt of benefits, or
certainty about the amount of benefit. The exact interpretation has
not been made clear. It seems that the intent of the government
is to migrate the entire existing NPS-S to the APY
[See Page
7 of the APY FAQs]. It is not clear that this is the right
approach. A careful examination of the lessons obtained from NPS-S
over the last four years (e.g. Sane and Thomas, 2015) would have helped
design a better response. Perhaps there was a role for
co-contribution separately from the pension guarantee.

2. Design of the procedure. There is considerable confusion
on how the APY is actually going to work. Initially, the APY was to
be sold through the same aggregators that distribute the
(NPS-S). New
documentation indicates that it is actually only open to bank
account holders. All the existing NPS-S customers are to be migrated
to the APY with an option to opt-out. Does this place the
responsibility of opening bank accounts for NPS-S customers on the
aggregators? What happens to those who wish to continue with the
NPS-Lite i.e. use the NPS without the co-contributions? In that
case, the PFRDA ought to define well-defined standards of skill and
care that aggregators will be expected to exercise towards a
customer as invariably the aggregator will end up playing the role
of an advisor when making a decision on whether to opt-out of the
APY, or continue only the APY or continue the APY along with
NPS-Lite.

The scheme levies penalties on those who are not able
to maintain the required balance in the savings bank account for
contribution on the specified date and close bank accounts if
contributions are not paid for 24 months. However, we know from the
NPS-S experience that informal sector workers often do not have
liquidity, are not able to contribute on time, but do come back over
subsequent periods. This design of the APY will invariably exclude
those who cannot maintain a balance in their savings bank accounts
or make regular contributions, defeating the purpose of providing a
formal sector savings mechanism.

3. Price of the guarantee. Apparently innocent guarantees
can prove to be disastrously costly when viewed in their entirety
(e.g. Shah, 2003). The APY seems to be motivated by the desire of the
government to ensure that on contributing continuously, a member gets
at least a pension of Rs.1,000. While not explicitly specified, the
APY seems like a minimum return guarantee which will ensure that
accumulated savings at retirement do not fall below a certain
value. There are different
kinds of guarantees, and several
ways to design minimum return guarantees. For example, an absolute
rate of return guarantee promises a pre-specified rate of return,
while a relative rate of return guarantee promises a return close to
the average of all funds. The motivation for the choice of this
particular design, and the calculations that influenced the choice
have not been articulated. Under the APY the
subscriber may actually be getting a sub optimal return. This is
not surprising, as all guarantees come at a cost
(Pennacchi, 1999). However, policy makers need to show the application
of mind: the class of guarantees which was evaluated, and the logic
that led up to this choice. The contributions under APY are to be
invested as per the investment guidelines prescribed by Ministry of
Finance, Government of India. The investment guidelines, and how they
would finance the guarantee of the APY are not yet clear.

4. Safeguards against arbitrary increases. Almost all
pension guarantees in the world have turned into fiscal problems. Even
if a guarantee is fiscally sound at the outset, modifications to the
program design later on render it bankrupt. Governments are tempted to
increase benefits prior to an election. Apparently innocuous changes
are announced, which add up to many percentage points of GDP. Any
guarantee program requires an elaborate array of safeguards to protect
against reckless actions in the future. The APY features no
safeguards. It does not require governments to show actuarial
calculations before any changes to the design are introduced. An
example of a defined benefit guaranteed return plan running into
funding difficulties is the Employees
Pension Scheme (EPS). Estimates
suggest that the EPS is facing a shortfall of Rs.54,000 crore, and
several changes
in scheme design have now been put in place owing to these funding
difficulties.

5. Improper process. Indian finance has taken a big step
forward by committing to the Handbook
on adoption of governance enhancing and non-legislative elements
of the draft Indian
Financial Code. The procedural requirements in the
Handbook, for framing regulations include a statement of
objectives and a cost benefit analysis of each of the provisions. Many
of the mistakes of the APY could have been avoided by the use of this
process. It is not too late to apply this process to APY, even
now.

3 comments:

After the launch some things are clear, but its not clear if tax-payers can avail the scheme or they can not avail the Govt. contribution of Rs1000/- per year. Is the scheme worth investing - an investment of approx Rs1500/- is returned as Rs. 5000/- after 20 years - which should leave Govt with an amount of Rs.3000/-. Even if one lives for 20 years after 60 the Govt is still paying out of the earlier interest saved - which now means Govt is saving about Rs.6000/- once again.... (based on calculation that approximately doubles money in 8 years)? How is this different from what one can get by regular investment in banks / mutual funds etc....except of assured interest..... can someone calculate the NPV of funds one can expect if one lives to 100?

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